Question

(Related to the Apply the Concept on page 156 ) Ira Goldman invented the Knee Defender, which keeps the airline seat in front of a passenger from reclining. He argues that airlines have sold the space between two seats to the person occupying the seat but also to the person in the seat in front of that seat by allowing the occupant of that seat to recline it. Assume that Goldman is correct. According to the Coase theorem, does this airline policy make it impossible for passengers to achieve an economically efficient outcome with respect to the issue of reclining seats? Briefly explain.

Short answer

No, according to the Coase theorem, this airline policy does not make it impossible for passengers to achieve an economically efficient outcome. The passengers could potentially negotiate among themselves to reach an efficient outcome, taking into account their individual preferences and the rights to the seat recline. This, however, assumes low transaction costs and may not hold true in practical situations.

Step-by-step solution

Defining the Coase Theorem

The Coase theorem says that in the presence of conflicting property rights, if trade in these rights is possible and there are sufficiently low transaction costs, bargaining will lead to an outcome which is efficient, regardless of the initial allocation of rights.

Apply the Coase theorem to the question

Applying the Coase theorem to this case, it implies that if property rights are clearly defined (in this case, whether the seat space belongs to the person sitting or the person in front) and transaction costs are low (no significant barriers for negotiation between passengers), an efficient outcome could be reached by allowing the passengers to negotiate their preferences to recline or not.

Conclusion

In theory, this airline policy allows for potentially economically efficient outcomes. For instance, if the passenger behind doesn't want the seat in front to recline, they could negotiate with the passenger in front (by possibly offering to buy them a drink), enabling both to reach an optimal solution satisfying both parties. However, this conclusion is theoretical and may vary based on various practical aspects such as personal preferences, social norms, and the practicality of negotiation among passengers in real life.

Key concepts

Economic Efficiency

One key term related to the Coase theorem is economic efficiency, a principle suggesting that an economy is using its resources in the most productive way possible. In the context of the economy of an airplane cabin, economic efficiency would mean that the space between the seats should be used in a manner that maximizes the well-being (or utility) of the passengers.

Applying this idea to the Knee Defender scenario, economic efficiency would be achieved if passengers could create an agreement satisfying everyone's preferences to the highest degree, given the limited resource: space. For instance, perhaps the passenger who values reclining slightly less than the the passenger behind values their legroom might agree to accept some form of compensation in exchange for not reclining. This form of negotiation leads to what economists call a Pareto improvement—an economic situation where resources are reallocated in a way that makes at least one person better off without making anyone else worse off.

Understanding Pareto Improvements

A Pareto improvement is a change to the allocation of goods and services that helps at least one person while harming none. Under the theorem, negotiation is the tool that leads to such improvements, revealing individuals’ true valuations of their right to recline or keep their legroom. Such exchanges are the heart of efficient economic transactions.

Property Rights

The concept of property rights is essential to understanding the Coase theorem. Property rights refer to the legal rights to own, use, and exchange properties or assets. Clear definition and enforcement of these rights is crucial because it determines how resources are utilized and who has authority over them.

In the case of airline seats, the lack of clarity about who 'owns' the space between reclining seats can lead to disputes and inefficiency. The Knee Defender situation highlights how unclear property rights - whether the space belongs to the passenger in the rear who desires more legroom, or the passenger in front who wishes to recline - can create conflict and hinder economic efficiency. The Coase theorem posits that as long as property rights are well-defined and transaction costs are minimal, parties can negotiate to resolve the conflict and achieve an efficient outcome.

Implication for Airlines

Airlines could facilitate efficiency by clearly defining property rights. For example, by explicitly stating who controls the space between seats or providing options for passengers to 'purchase' more legroom or additional space to recline, airlines can reduce conflicts and encourage a marketplace for seat space, leading to potentially more satisfied customers.

Transaction Costs

A fundamental aspect of the Coase theorem is the role of transaction costs. These costs entail the expenses of making economic exchanges. They can include monetary costs, time, effort, and even the psychological burden of negotiations. Transaction costs can have a significant impact on the likelihood and efficiency of bargains between parties.

Applied to the airline context, high transaction costs may deter passengers from negotiating seat reclining rights, leading to an inefficient outcome and dissatisfied passengers. This could reveal itself in several forms, such as the awkwardness of starting a conversation with a stranger, the potential for confrontation, or the challenge in assessing what compensation would be appropriate.

Minimizing Transaction Costs

To approach the economic efficiency suggested by the Coase theorem, airlines could develop systems that streamline such negotiations. For example, they might design a protocol or app that allows passengers to state their seat preferences and compensate each other without the need for a direct, and potentially uncomfortable, conversation. By reducing transaction costs, airlines would enhance the likelihood of efficient outcomes, where passengers reach agreements that reflect the true value they place on seat space and comfort.